The demand by the Obama administration for the Israelis to fully and completely freeze all settlement activities has become a point of contention between the US and Israel for a number of reasons.
Jewish settlements built on lands occupied by Israel in 1967 is considered by the international community to be totally illegal and in clear violation of the fourth Geneva convention which is aimed at regulating prolonged occupations. The International Court of Justice at the Hague ruled in July 9, 2004 at the Hague as much when considering an appeal against Israel for building a wall inside Palestinian territories. Successive US administrations have also repeated rejected settlement activities but have wavered from calling it "illegal," to calling it an "obstacle to peace."
The UN security council has also ruled against settlements in numerous occasions, directly or in the prelude, to various resolutions.
While building facts on the ground after illegally (according to international law) confiscating Palestinian lands, the Israelis have often played games with the international community on this issue. Israelis as late as Thursday have tried to finesse the issue in various ways. From arguing that Jews have a right to build anywhere they choose (a right that they forcefully deny to Palestinians in parts of the West Bank as well as in Jerusalem and in all of pre-67 Israel) to the more recent claim that Jewish settlements in Palestinian territories have a right to 'natural growth.'
Settlement activities including the so-called natural growth are clearly rejected in the road map agreement which Israel signed to and the Knesset approved. Even far right wing Israeli foreign minister Avigdor Leiberman said on his first day in office that he accepted the Road Map (while stressing his rejection to the two state solution as stated in the Annapolis Process). US Secretary of State Hillary Clinton speaking on Al Jazzera TV (that in itself is a change of Washington's bias to Al Arrabiya TV) stressed clearly and unamgiously the Obama administration's rejection to any settlement activities including and these are her words, natural growth.
It is not hard to understand why everyone who supports a two state solution sees settlement activities in what will become the Palestinian state as knife in the heart of such a deal. The previous as well as the current US administrations considers the creation of a viable Palestinian state with contiguity in the "national interest" of the United States. It follows that any actions that directly block the chances of a viable and contiguous Palestinian state as actions that are against US national interests and not just Palestinian interests.
Palestinians are naturally pleased that Washington is finally serious about at least this one crucial aspect of the conflict. Palestinians who aspire to being free of occupation might be willing to wait for the logical outcome of the negotiations. Slow or fast negotiations the one specific aspect that Palestinians worry about is what these "facts on the ground" can affect the final outcome of negotiations. Palestinians still remember in anger and anguish the private letter from President George W. Bush to former Israeli prime Minister Ariel Sharon in which Bush Jr. expresses understanding of the wishes of Israel to keep some of the large settlement blocks in any final resolution. It is exactly this fear of a small confiscation, followed by the creation of a military outpost, which is then miraculously transferred into a civilian outposts and finally becoming a full fledged settlement that US presidents want Palestinians to accept as a reality that worries Palestinians.
The Palestinian president Mahmoud Abbas has been an active fighter against any attempts to resolve the Palestinian conflict with Israeli in a violent way. As the PLO's number two man, he spoke against the 'militarization' of the 2000 second intifada. He continued his opposition to military resistance as president. But for a peaceful negotiated solution to work, the Palestinian leader can't carry out any face to face negotiations with the Israelis while they are daily carrying out activities on the ground to block the potential of a peace agreement that includes a viable independent state with land contiguity. Senior Palestinian negotiator Ahmad Qreia has even offered Israelis settlers living in the Palestinian territories to remain in their homes so long as they accept to live under Palestinian rule in a Palestinian state. In an interview with HaAretz he even offered that they can be dual citizens if they choose.
Forty one years after Israeli troops occupied Palestinian lands (in contradiction to international law which called this occupation 'inadmissible') and after hundreds of illegal settlements built on this Palestinian land, it should be understood why the issue of settlements has become a defining issue for peace in the region.